What is return on investment?
Return on investment (ROI) is a profitability metric used to evaluate the efficiency or profitability of an investment relative to its cost. Expressed as a percentage, ROI helps businesses and individuals determine how much financial return they are generating for every dollar invested — making it one of the most widely used financial performance indicators.
The formula for ROI is:
ROI = [(Gain from Investment – Cost of Investment) ÷ Cost of Investment] × 100
For example, if a business spends $10,000 on a marketing campaign and generates $15,000 in additional revenue, the net gain is $5,000. The ROI would be 50%, meaning the business earned 50 cents for every dollar invested.
Types of ROI
ROI can be calculated in two forms depending on the stage of the investment:
- Anticipated ROI: Calculated before a project begins, using estimated costs and revenues to assess whether the investment is worth pursuing
- Actual ROI: Calculated after a project is complete, measuring the real profit generated compared to the original estimate
Limitations of ROI
While ROI is a straightforward and versatile metric, it does have limitations:
- It does not account for the time taken to generate the return — a 50% ROI over 10 years is very different from a 50% ROI over one year
- It does not factor in intermediate costs such as ongoing maintenance or brokerage fees
- It does not consider the risk associated with an investment
For Australian businesses, ROI is commonly used to evaluate the performance of marketing campaigns, equipment purchases, staff training programs, and capital investments. It is best used alongside other financial metrics for a complete picture of business performance.